How ETFs are bracing for the turbulence of El Niño

Savvy investors will be well aware of the portfolio risks posed by man-made climate change. But it is a naturally occurring weather cycle that is expected to have a bigger influence over everything from grain and cocoa prices to emerging market interest rates in the year ahead.

After the hottest month ever recorded in July, scientists have warned that El Niño — a weather phenomenon associated with a warming of the Pacific Ocean’s surface — is set to bring further meteorological turbulence to parts of South America, Asia, and Africa. 

Pockets of unusually warm weather roughly every seven years were first noticed by fishermen off the coast of South America during the 17th century. Since then, “Little Boy” has been found to disrupt crop cycles and even global prices for commodities, including timber, zinc and rubber. Researchers at Dartmouth College in the US estimate that this year’s El Niño could cost the global economy as much as $3tn in lost growth by the end of the decade. 

However, exchange traded funds offer one avenue to investors hoping to hedge against El Niño’s impacts on financial markets. Invesco’s DB Agriculture Fund and the Teucrium AiLA Long-Short Agriculture Strategy ETF are among the dozens of investment vehicles that provide exposure to commodities and other weather-related stocks.

“We’re in an El Niño cycle now and that’s going to disrupt some grain production in key places,” noted Jake Hanley, managing director and senior portfolio manager at ETF provider Teucrium, last month. He said that, for asset allocators, “commodities in general, and certainly agriculture, can be that asset class that zigs when other segments zag”. 

Food prices have been falling steadily since their peak in March 2022, after Russia’s full-scale invasion of Ukraine. Declines in the price indices for dairy, vegetable oils and meat have in recent months offset increases in the sugar and cereal price indices, denting year-to-date returns for many of the biggest agriculture ETFs. The iShares MSCI Agriculture Producers ETF, for example, has dropped 11 per cent over the past 12 months.

That trend may soon reverse, however. “Three shocks tilt food prices to the upside: the breakdown of the Black Sea grain initiative; new rice export restrictions; and El Niño,” say analysts at JPMorgan. Across the 166 countries for which both broad consumer price indices and food price indices are available, 80 per cent are showing food price inflation exceeding overall inflation, the bank points put. 

That inflationary pressure, in turn, could prevent a quick lowering of interest rates by central banks in emerging markets — where food accounts for roughly twice the share of spending on consumer goods compared with developed economies.

In Colombia, “a more severe or prolonged El Niño episode than expected could increase inflation expectations for price setters, costs, and wages”, JPMorgan analysts also warn. Central bankers in Thailand, India and Brazil have already flagged El Niño as a threat to their plans to ease monetary policy in the months ahead.

But, while policymakers worry, some investment funds are already reaping modest rewards.

Shares in the WisdomTree Agriculture ETC — which focuses on corn, coffee, cotton, wheat, sugar and soyabeans, all of which can be particularly sensitive to changing weather patterns — have risen 2.2 per cent in the 12 months to October 23. Analysts at Saxo Bank note that US agricultural futures enjoyed a “strong week” last week, with gains being led by wheat and corn.

There may be more to come. Export prices for Brazilian corn remain relatively cheap, but that “could change in the coming year as the growing conditions deteriorate . . . as is possible in an El Niño year”, suggests Jack Scoville, a broker at Price Futures Group in Chicago. 

He adds that, for palm oil, “traders still think that El Niño will cause big production problems down the road and are holding out hopes for rallies in the future”. Morgan Stanley says a strong El Niño season “could cause cocoa bean supply to decline further, possibly keeping costs high for longer”.

Sugar prices are already on the rise. The UN FAO Sugar Price Index rose 9.8 per cent in September to its highest level since November 2010 — in part because of early forecasts that suggest future production declines in key sugar producers Thailand and India. Unusually dry weather conditions associated with El Niño are partly to blame. Legal & General Investment Management told trade publication ETF Stream that its Enhanced Commodities Ucits ETF was overweight sugar at the start of October.

Across south and south-east Asia, weather patterns are also threatening supplies of rice, exacerbating the impact on global prices from India’s export ban in July. Indonesia has warned of a potential hit to output, while the threat of water shortages has forced Vietnam to instruct farmers to plant their next rice crop earlier than usual. 

“El Niño threatens many key agricultural products and also strains power grids, impacts fishing, and cuts off access to mines due to flooding,” says Ehsan Khoman, head of commodities, ESG and emerging markets research at MUFG Bank. “Tightening global supply and a renewed rally in food prices are key worries threatening global markets.”

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